Thursday, April 28, 2011

This post is in response to Timothy Lee's article "The bitcoin bubble." In this article Lee argues that the rising price of bitcoin is temporary and a fad. I wish to point out some wrong assumptions, logical fallacies, and omissions that his article makes.

In his article Lee is restrictive in his thinking. His article mainly mentions dollars as a competing currency. He fails to address bitcoins which trade for euros, rubles, or British pounds. Bitcoins know no borders and they may be more useful in one country than another. Lee fails to consider these facts. This point is most clear when he argues that bitcoins will never replace dollars. This is a straw man argument as no one has suggested that bitcoin will replace traditional currencies. All that has been shown is that bitcoin replaces dollars or other currencies in some cases. Bitcoin proponents may suggest that these cases will grow as bitcoin gets more exposure.

Lee puts up another straw man when he argues that there will always be demand for dollars because taxes will require dollars. This assertion is true, but it gives the reader the false impression that bitcoins are to replace dollars. Lee also fails to acknowledge that bitcoins are attractive to people who do not wish to support wars of their governments. Lee also fails to acknowledge that the fact that bitcoin transactions will be difficult to tax actually is an advantage of bitcoin.

It is curious that Lee refers to bitcoins as ones and zero's in a database, after quoting a description of bitcoin that refers to it as peer to peer and thus not dependent on a central data base. It's strange that such a discrepancy is made in the article. He complains that people who exchange bitcoin will have to do extra math. He fails to recognize that there are people who like math. He also suggests that risk will keep people away. If this were true there would be no stock market. Every one would buy gold for an investment, an investment with less risk that traditional currencies. He argues that people will have to cash in bitcoins to make traditional purchases. This ignores the fact that people can hold both currencies and use whichever is most convenient and/or profitable.

The most glaring glossing over in his article is his discussion of the drug trade and illicit markets. It is not hard to find where drugs are being sold for prices only quoted only in bitcoin. As drugs are illegal in many countries their supply can be limited in certain areas of the world. This results in high prices that are paid for drugs, and will create background demand for bitcoins. Specifically, an eighth of an ounce of high quality marijuana sold for 40 BTC at the time of Lee's article. Now, the same product sells for 20 BTC. We are witnessing a feedback loop. Hard to obtain products offered for bitcoin, value of bitcoin goes up. Value of bitcoin goes up, bitcoin price of hard to obtain product goes down. Bitcoin price of hard to obtain product goes down, value of bitcoin goes up. This process can repeat indefinitely, as the bitcoin market cap increases the upward swings should become less dramatic.

Bitcoins do have a certain utility that other currencies do not offer. This utility may not appeal to everyone, but it will appeal to some. As it does appeal to some people, the utility of bitcoins will increase. This will encourage others to participate. While bitcoins may never be a world currency, they are used by some, and as such are already a success.